How Do You Account for Advance to Employees? (Definition, Example, Journal Entries)

Definition

The advance to employees is essentially a short-term, interest-free loan to the employee. It is usually cash-based and, in this case, the employee who is the borrower gets an advance payment of their earnings from the lender, which is the employer.

It is most likely that this amount will be repaid by the employee upon the next wage payment to them.

The amount of advance the employee receives, is one which they have not earned yet as the services for that payment have not been rendered yet.

Therefore, any payments made to the employee in advance are regarded as assets for the business and because this advance is for a short term only, it will be included in the current assets of the company.

Advance to employees can be recorded under any of the account heads as deemed suitable by the business. These account heads are most likely to be:

  • Other Receivables
  • Advance to employees
  • Other assets
  • loan to employees (if the company plans to charge an interest on the amount of advance, it is most likely to use this account)

However, if these advances are mostly infrequent, the company will most likely use other assets or other receivables account to record them.

If such advances are frequent for the company, then they may open a dedicated general ledger account for these advances, which may include payroll advance account, wage advance account, or salary advance account.

Regardless, these accounts will still be a part of the current assets of the company. It is however important to use a separate account for recording these advances and not to include them in the usual salary or wages account because the salary and wages accounts must only be used to record the actual salary or wage expense that has been incurred during the financial period.

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Journal Entry for Advance to Employee

When advance payment is given to the employee from their future wages, this has to be recorded as a reduction to cash and an increase to the current assets of the company. As such, the company must make the following journal entries to record the advance to employees:

DateDetailsDebit ($)Credit ($)
xxxOther receivablesxxx 
  Cash/Bank xxx
Cash advance issued to the employee.

As a part of this entry, when an advance is given to the employee, the company makes a debit entry to other receivables accounts and a credit entry to the cash account. This allows the company to correctly record the decrease in cash while recording the increase in the current asset receivable account.

Similarly, when this advance is paid back by the employee, the company must make an adjusting entry to eliminate the amount of advance paid by the employee against their salary account or cash/bank account if the employee pays back by cheque.

Journal Entry for Advance to Employee- An Example

The example below will show how to record payroll advance or salary advance to employees.

Company ABC provides a cash advance to an employee on 20th May 2021 of $250. This advance must be repaid by the employee at the end of the month upon the receipt of wages for the month.

This journal entry will be recorded as:

DateDetailsDebit ($)Credit ($)
20-MayOther receivables250 
  Cash/Bank 250
Cash advance issued to the employee.

This entry will allow the company to record the reduction of cash as well as the increase in the current assets when the advance is given to the employee.

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On 31st May 2021, the net wages due to the employee were $1,000. The amount of cash advance will now be deducted from the employee’s net wages.

DateDetailsDebit ($)Credit ($)
31-MayWages1000 
  Other receivables 250
  Cash/Bank 750
Cash advance issued to the employee.

At the end of the month, when the remaining salary of the employee is paid, the amount of the advance will be paid back by the employee.

In some cases, the employee may want to pay back the amount of advance in installments rather than in full at the end of the month. In such cases, the company must continue to credit the other receivables account or whichever asset account was used while issuing the advance, until the time the advance is paid back in full by the employee.

However, it is important that the company is careful in allowing such advances and this may encourage employees to use cash advances frequently and rather use the company payroll as a substitute of bank overdraft, for example. In an ideal situation, the cash advances to employees must be limited to a few only during a year.

Conclusion

To conclude what has been explained above, advance to employees is a short-term loan given to the employee by the company making the employee a borrower and the company a lender.

Such advances are paid out of the monthly salary or wages of the employee and must be paid back by the employee by the end of the month in full in usual cases.

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In most cases, the company records such advances in the payroll advance account or other receivables account, while making a deduction to the cash account.

When the amount is paid back by the employee at the end of the month, or as per the mutual agreement of the employee and the company, the amount of the cash advance is credited from the asset account used while issuing the advance until the balance for the advance is null. 

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